by Doug Drabik, Fixed Income, Raymond James
November 27, 2017
How flat can we go? It seems like every week we see the short end (3 years and in) of the Treasury curve move up a few basis points in yield while the longer end (10 years and out) moves down a few basis points in yield. To put this in perspective, the slope between the 2- and 10-year Treasuries was 126 basis points (bp) at the start of the year. It has been sliced in half to 60bp. The 1- to 30-year slope was 225bp to start the year and is now 118bp.
The yield curve had steepened tremendously at the end of the great recession. At the beginning of 2010, the 1- to 30-year slope had widened to 419bp. Keep in mind that slope exists primarily because investors demand more yield for taking on greater risk, the risk of what can happen over a longer period of time. Since expectations for future inflation were very high, investors demanded even greater returns and longer term Treasury yields were driven up.
Data releases such as the consumer price index (CPI) or personal consumption expenditure (PCE), are typical gauges of inflation. Over the last 5 years, both have been confined to low ranges with seemingly little resolve to break much higher. Slowly expectation of future inflation has tapered and investors seem to be protecting against continued low inflation now (as opposed to fear of elevated inflation) helping to keep longer term rates down.
The expectation that the Fed will raise interest rates has been well-known for years. At the beginning of the last several years, we have been greeted with the forecasts of numerous Fed interest rate hikes. In actuality, we have seen only four 25bp hikes starting on December 16, 2015. Not one point on the yield curve is 100bp higher since December 15, 2015, the day before the first Fed hike. The 10-year Treasury is basically flat (up 5bp) and the 30-year Treasury is down 23bp over the four Fed hike period starting in December, 2015 to the present. The greatest uptick on the yield curve during that time span is the 1-year Treasury which is up only 93bp.
Some comments about inverted curves have been mentioned probably because the last four recessions were preceded by them. The markets, although getting flatter, still maintain some slope and the economy, albeit slowly, continues to show signs of growth; however, prospects for fiscal stimulus have weakened since the election of President Trump. The excitement of campaign promises has faded because getting Congress on board has proved difficult.
So what can be expected? The bond market typically proves itself efficient. Without any stimulus, if rates get flat enough, investors will choose shorter maturities with similar yields without the risks associated on longer maturities. Over time, this could be the catalyst to drive longer term rates higher. The wild card in all of this may be in the composition of the Fed and the future policies. Once Fed Chair Yellen steps down, four of the seven board members are open positions to be appointed by the Trump administration. The composition may be very different and will be a great influence on forward policy.
There are a lot of factors at play moving into the year’s end. We will keep an eye on inflation, the pace of economic growth, central banks policies and the reshaping of our own Fed board.
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To learn more about the risks and rewards of investing in fixed income, please access the Securities Industry and Financial Markets Association’s “Learn More” section of investinginbonds.com, FINRA’s “Smart Bond Investing” section of finra.org, and the Municipal Securities Rulemaking Board’s (MSRB) Electronic Municipal Market Access System (EMMA) “Education Center” section of emma.msrb.org.
The author of this material is a Trader in the Fixed Income Department of Raymond James & Associates (RJA), and is not an Analyst. Any opinions expressed may differ from opinions expressed by other departments of RJA, including our Equity Research Department, and are subject to change without notice. The data and information contained herein was obtained from sources considered to be reliable, but RJA does not guarantee its accuracy and/or completeness. Neither the information nor any opinions expressed constitute a solicitation for the purchase or sale of any security referred to herein. This material may include analysis of sectors, securities and/or derivatives that RJA may have positions, long or short, held proprietarily. RJA or its affiliates may execute transactions which may not be consistent with the report’s conclusions. RJA may also have performed investment banking services for the issuers of such securities. Investors should discuss the risks inherent in bonds with their Raymond James Financial Advisor. Risks include, but are not limited to, changes in interest rates, liquidity, credit quality, volatility, and duration. Past performance is no assurance of future results.
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